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Independence Day fireworks: Mortgage market rocked by soaring rates

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The biggest jump in interest rates since 1987 is pummeling the mortgage market and raising worries about the health of the robust housing rebound that has been fueling economic growth this year.

A report from the Mortgage Bankers Association on Wednesday showed the nation's vital mortgage market got hit hard by a surge in the average rate on 30-year loans to a two-year high of 4.58 percent last week. The refinancing boom that has underpinned economic growth since 2009 was the biggest casualty, with refinancing applications plummeting 16 percent to a two-year low, but the report also showed a 4 percent drop in mortgage applications for home purchases, in a sign that the sizzling housing recovery may also be in jeopardy.

The abrupt end of ultra-low mortgage rates in the 3.5 percent range in the last two weeks was precipitated by a change in the outlook at the Federal Reserve, which late last month signaled it is planning a retreat from its longstanding easy money policies, possibly by the end of the year.

The Fed's telegraphed plans shook up the mortgage market almost overnight, but it has prompted some who were thinking about buying a home to rush into the housing market before interest rates go even higher.

Economists expect that rush to market to push up home sales and prices in the next month or two, but the question is what will happen to the housing market after the frenzy of last-minute home-buying fades and the reality of significantly higher mortgage rates set in.

"The housing market is already feeling the impact of higher mortgage rates and by August the full effect those rates have on housing affordability will begin to show up in economic data," said Scott Minerd, managing partner at Guggenheim Partners. "Given the increasing importance of housing to the overall economic recovery, a drag on housing activity will undoubtedly hold back growth."

Mr. Minerd said the best hope for the economy is that interest rates will retrace some of their sharp gains as housing activity cools later this year, limiting the damage to the housing market and overall economy.

It is hard to exaggerate how sharp and disruptive the surge of a percentage point or more in interest rates has been in the last two weeks since Fed Chairman Ben S. Bernanke detailed how the central bank might end its massive purchases of Treasury and mortgage bonds in the next few months. By driving the yields on mortgage bonds and Treasury securities to two-year highs, the Fed prompted a mass exodus from bond investment funds that eclipsed even the flight that occurred during the 2008 financial crisis.

Funds that specialize in mortgage-backed securities experienced their biggest losses in nearly two decades last quarter as a result, Reuters reported. In all, nearly $79 billion was withdrawn from bond funds and exchange-traded funds that specialize in bonds in late June, far surpassing the $42 billion withdrawn as the credit crisis peaked in the fall of 2008, Bloomberg reported.

Still, many housing analysts and professionals remain hopeful that the long-suffering housing market — which was enjoying its first full year of strong revival after a deep, five-year-long recession — will stand up in the face of higher rates. They note that home prices remain near the lowest levels since 2003 and mortgage rates are still within an historically low range, though they are up from the record lows induced by the Fed's easing programs in the last two years.

"Affordability remains strong" despite the higher rates, said MBA vice president Michael Fratantoni, noting that mortgage applications for purchases were not hit has hard as refinancings last week and remain above year-ago levels.

Ted Wieseman, economist at Morgan Stanley, agreed that housing affordability remains high despite the jump in mortgage rates to more than 4.5 percent from record lows under 3.5 percent only a few weeks ago. The rate jump has increased the average monthly mortgage payment on a median-priced U.S. home by a little more than $100 to $846 from $738, he said, but that's still well within the capacity of most American households to pay.

"It might price some prospective buyers out of the market," but the biggest obstacle to home sales remains not so much the level of interest rates as the reluctance of banks to give out loans, he said.

Mr. Wieseman added that ironically, the rapid rise in rates may actually help buyers a little by prompting lenders to offer more loans to home buyers, since the lucrative business of refinancing has all but dried up and will not be the source of big profits it was for banks in the last few years. Banks will be forced to go out and generate new business by offering new loans to buyers to make money in the future, he said.

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